Why we expect M&A in tech to continue

09/06/2016By Sammy Abdullah, CFA

Now is a great time for M&A and notable acquisitions of late include Microsoft’s acquisition of LinkedIn, Salesforce’s acquisition of DemandWare, and Verizon’s acquisition of Yahoo. Given the strength of many tech company balance sheets, we expect the trend to continue. Below is the analysis.

First, we grouped 80 tech companies by their 5 major respective industries (Social, Marketplaces, Content Distributors, Gaming, SaaS) and laid out some of their key financials including OCF (operating cash flow), debt, and cash. The data is below.

$in MM's

TTM

TTM

TTM

Debt/

Cash/

Company

Ticker

Revenue

EBITDA

OCF

Debt

Cash

OCF

OCF

Social

Facebook

FB

$22,160

$11,080

$11,200

$0

$23,290

0.00x

2.08x

Linkedin

LNKD

$3,430

$396

$1,000

$1,150

$3,310

1.15x

3.31x

Line Corp

LN

$1,300

$159

$206

$420

$430

2.04x

2.09x

Twitter

TWTR

$2,480

-$4,890

$578

$1,620

$3,590

2.80x

6.21x

Median

$2,955

$277

$789

$785

$3,450

1.6x

2.7x

Marketplaces

Priceline

PCLN

$9,810

$3,710

$3,500

$7,260

$4,370

2.07x

1.25x

eBay

EBAY

$8,790

$3,070

$3,130

$9,050

$8,090

2.89x

2.58x

Sabre

SABR

$3,250

$739

$539

$3,280

$68

6.09x

0.13x

TripAdvisor

TRIP

$1,470

$205

$440

$92

$853

0.21x

1.94x

Shutterstock

SSTK

$464

$61

$87

$0

$266

0.00x

3.06x

Match Group

MTCH

$1,120

$289

$229

$1,210

$174

5.27x

0.76x

IAC

IAC

$3,250

$381

$330

$1,710

$1,330

5.19x

4.03x

Expedia

EXPE

$7,740

$838

$1,430

$3,210

$2,340

2.24x

1.64x

Etsy

ETSY

$321

$30

$35

$12

$278

0.36x

8.04x

Lending Club

LC

$508

$0

$52

$0

$573

0.00x

11.06x

Angie's List

ANGI

$340

$33

$18

$58

$58

3.26x

3.29x

Zillow

Z

$741

$7

-$54

$230

$420

-4.26x

-7.78x

Groupon

GRPN

$3,120

$7

$85

$227

$780

2.69x

9.22x

GrubHub

GRUB

$418

$94

$51

$0

$270

0.00x

5.25x

Care.com

CRCM

$151

$0

$14

$0

$56

0.00x

4.02x

Median

$1,120

$94

$87

$227

$420

2.1x

3.1x

Content Distributors

Yahoo!

YHOO

$4,890

$151

$1,050

$1,270

$6,380

1.21x

6.08x

Google

GOOGL

$81,760

$26,900

$28,980

$6,270

$76,940

0.22x

2.65x

Yelp

YELP

$629

-$9

$60

$0

$398

0.00x

6.61x

TrueCar

TRUE

$264

-$34

-$1

$29

$103

-31.89x

-114.56x

WebMD

WBMD

$671

$163

$151

$1,040

$1,020

6.89x

6.75x

Netflix

NFLX

$7,620

$314

-$896

$2,370

$1,830

-2.65x

-2.04x

Pandora

P

$1,290

-$159

-$118

$243

$293

-2.07x

-2.49x

Median

$1,290

$151

$60

$1,040

$1,020

0.0x

2.7x

Gaming

Activision Blizzard

ATVI

$5,370

$1,520

$1,640

$5,030

$2,270

3.07x

1.38x

Electronic Arts

EA

$4,460

$1,120

$1,050

$1,120

$3,430

1.07x

3.27x

Take-Two Interactive

TTWO

$1,450

$121

$109

$504

$1,190

4.65x

10.97x

Zynga

ZNGA

$750

-$20

$10

$0

$868

0.00x

91.41x

Median

$2,955

$621

$579

$812

$1,730

2.1x

7.1x

SaaS

2U

TWOU

$177

-$22

-$4

$0

$188

0.0x

-49.5x

Athenahealth, Inc.

ATHN

$1,010

$85

$171

$295

$134

1.7x

0.8x

Bazaarvoice, Inc.

BV

$200

-$15

$19

$42

$95

2.2x

4.9x

Benefitfocus, Inc.

BNFT

$212

-$36

-$35

$75

$68

-2.1x

-1.9x

Box, Inc.

BOX

$327

-$156

-$38

$56

$183

-1.5x

-4.8x

BroadSoft, Inc.

BSFT

$314

$38

$64

$195

$264

3.0x

4.1x

Castlight Health, Inc.

CSLT

$82

-$77

-$58

$0

$121

0.0x

-2.1x

Cornerstone OnDemand, Inc.

CSOD

$389

-$52

$48

$234

$267

4.9x

5.6x

Cvent, Inc.

CVT

$211

$8

$46

$0

$177

0.0x

3.8x

Five9, Inc.

FIVN

$145

-$5

-$1

$44

$58

-48.3x

-64.0x

Fleetmatics Group PLC

FLTX

$311

$67

$99

$23

$194

0.2x

2.0x

Hortonworks, Inc.

HDP

$155

-$219

-$98

$0

$109

0.0x

-1.1x

HubSpot, Inc.

HUBS

$225

-$41

$11

$1

$117

0.1x

11.1x

IntraLinks Holdings, Inc.

IL

$285

$14

$35

$80

$39

2.3x

1.1x

Jive Software, Inc.

JIVE

$202

-$14

-$10

$2

$108

-0.2x

-10.9x

Lifelock

LOCK

$632

$35

-$38

$0

$156

0.0x

-4.1x

LinkedIn Corp.

LNKD

$3,430

$396

$1,000

$1,150

$3,310

1.2x

3.3x

LivePerson Inc.

LPSN

$232

$16

$36

$0

$52

0.0x

1.4x

LogMeIN, Inc.

LOGM

$309

$37

$91

$45

$225

0.5x

2.5x

Marin Software, Inc.

MRIN

$108

-$8

$5

$2

$35

0.5x

7.2x

Marketo, Inc.

MKTO

$241

-$51

-$4

$1

$100

-0.3x

-25.5x

Medidata Solutions, Inc.

MDSO

$421

$52

$96

$256

$318

2.7x

3.3x

MobileIron, Inc.

MOBL

$158

-$65

-$35

$0

$85

0.0x

-2.5x

NetSuite Inc.

N

$846

-$59

$117

$286

$408

2.5x

3.5x

New Relic, Inc.

NEWR

$202

-$61

$10

$0

$196

0.0x

20.6x

Proofpoint, Inc.

PFPT

$313

-$60

$57

$356

$412

6.2x

7.2x

Qualys, Inc.

QLYS

$182

$43

$75

$0

$214

0.0x

2.9x

RealPage, Inc.

RP

$514

$68

$108

$124

$47

1.2x

0.4x

RingCentral, Inc.

RNG

$339

-$9

$19

$17

$148

0.9x

7.7x

salesforce.com, Inc.

CRM

$7,070

$522

$1,930

$2,070

$2,030

1.1x

1.1x

ServiceNow, Inc.

NOW

$1,190

-$91

$98

$491

$807

5.0x

8.2x

Splunk, Inc.

SPLK

$729

-$291

$163

$0

$1,020

0.0x

6.3x

SPS Commerce, Inc.

SPSC

$176

$18

$21

$0

$128

0.0x

6.2x

The Ultimate Software Group, Inc.

ULTI

$700

$66

$120

$10

$98

0.1x

0.8x

Veeva Systems Inc.

VEEV

$439

$87

$148

$0

$457

0.0x

3.1x

Wix.com Ltd.

WIX

$241

-$45

$27

$0

$128

0.0x

4.8x

WorkDay, Inc.

WDAY

$1,260

-$194

$328

$514

$2,080

1.6x

6.3x

Zendesk, Inc.

ZEN

$261

-$78

$15

$0

$224

0.0x

15.3x

Secureworks

SCWX

$362

-$57

-$18

$0

$124

0.0x

-6.9x

Appfolio, Inc.

APPF

$90

-$8

-$2

$0

$22

0.0x

-13.9x

Atlassian Corporation

TEAM

$457

$9

$130

$0

$743

0.0x

5.7x

Twilio

TWLO

$219

-$30

-$2

$0

$261

0.0x

-164.4x

Instructure

INST

$92

-$48

-$21

$0

$62

0.0x

-3.0x

Mindbody, Inc

MB

$120

-$24

-$13

$16

$88

-1.2x

-6.9x

Shopify

SHOP

$282

-$21

$11

$0

$180

0.0x

16.0x

Xactly

XTLY

$81

-$17

-$7

$15

$46

-2.3x

-7.0x

Median

$272

-$16

$20

$2

$152

0.0x

2.2x

*OCF defined as Net Income + Depreciation and Amortization, Total + Other Amortization +

Other Non-Cash Items, Total + Change in Working Capital

Looking at their OCF figures, we can see that many of the companies are quite healthy generating significant cash before debt service: in Social, MarketPlaces, Content Distributors, Gaming, and SaaS, the median OCF of each category for the last twelve months has been a healthy $789mm, $87mm, $60mm, $579mm, and $20mm. On median, all categories are cash flow positive which is important because it means cash isn’t needed to sustain current infrastructure. That leaves four primary ways these businesses can use current cash flow: growing the current business, a dividend, debt service, and M&A.

A dividend is unlikely as Wall Street would punish the stock (dividends are viewed as conceding there is little growth left in the business). That leaves growing the current business, debt service, or M&A as alternatives, so let’s first look at debt service as a potential use of cash. Looking at debt levels, these businesses have very healthy debt levels: Social, Marketplaces, Content Distributors, Gaming, and SaaS have median Debt/OCF ratios of 1.6x, 2.1x, 0.0x, 2.1x, and 0.0x respectively. Any finance nerd can tell you that’s a very low level of leverage. So, we can eliminate dividends and debt service as the primary uses of cash which leaves plowing cash into organic growth and M&A.

Companies will always plow cash into initiatives which result in organic growth so long as the opportunity and return is there. So, in order for M&A to be a possibility, there needs to be a significant level of cash on the balance sheet already or in other words, there needs to be more cash than the business currently needs to grow organically. Looking at the Cash/OCF levels of the businesses, we believe the argument for more M&A is compelling: Cash/OCF for Social, Marketplaces, Content Distributors, Gaming and SaaS is a strong 2.7x, 3.1x, 2.7x, 7.1x, and 2.2x. Said another way, the Social category already has 2.7 years of cash generation (OCF) sitting on the balance sheet as cash, so the only logical use of that cash after organic growth is exhausted is M&A.

Overall, the market looks ripe for more M&A, so keep building the best business you can and be patient as the M&A will eventually come to you. The balance sheets of tech companies are too healthy not to.